The India Microfinance Crisis, Reconsidered

I was prompted to start researching a book about Fonkoze when this microfinance/development institution – Haiti’s largest in terms of number of clients – willed itself back into existence and relevance within days of the devastating earthquake in January 2010. In time, donors with pockets deep and otherwise helped bankroll the revival strategy, but in its early days it was the sheer force of a few leaders’ wills imposing itself on a future that was uncertain to say the least.

Well, this project has taken a detour to visit the scenes of two other disasters that hit leading microfinance institutions (MFIs) in 2010 – though these were far from natural, but rather socio-political in nature. The governments of Bangladesh and the Indian state of Andhra Pradesh (AP) took aim at a leading MFI (in the case of Bangladesh) and the entire sector (in AP). Unraveling these two temblors seems important to understanding Fonkoze’s past, present and future. So I travelled to Bangladesh and India to start part two of my sabbatical in order to learn more.

I have already written about my impressions of Bangladesh, so let me turn now to India. Much has been written about the microfinance crisis there. For my part, I have made public statements about it, transcribed and released of my debate with SKS founder Vikram Akula at the Asia Society (which took place at the outset of the crisis), and addressed the issue in the opening section of my chapter in New Pathways out of Poverty (the Spanish and French versions of which are freely available, as they are not protected by copyright). David Roodman gave an impressive account of the crisis in his book Due Diligence, which I have reviewed (a review to which Roodman thoughtfully responded).

However, when I went to India I tried to free myself from preconceptions, and attempted to listen and observe with an open mind. I met with leaders of MFIs large and small, as well as other members of the ecosystem including consulting firms, industry associations, and the staff of Grameen Foundation’s wholly owned subsidiary Grameen Foundation India and our joint venture Grameen Capital India (both of which are organized as social businesses as per Professor Muhammad Yunus’ definition). Below is a list of eight things I learned that I did not know, or believe, before I arrived:

Despite recent progress in terms of returning the sector to normalcy outside AP, and in advancing legislation that is flawed but still a net positive, I heard from multiple sources that that state government of Tamil Nadu is considering an AP-type of ordinance that would throw the Indian microfinance sector into a new and probably much deeper crisis. Stay tuned!

At the height of the frenzied growth during the period 2007-10, many MFI field officers came to rely on so-called “agents” (also known as “ringleaders”) at the village level who took on many of the functions of staff. In effect, field staff were outsourcing their client recruitment and loan underwriting responsibilities. This was a ticking time bomb, as the MFIs effectively lost control of their own activities, most importantly in terms of their relationships with loan clients. The reasons for this probably include the lack of training given to the new recruits of fast-growing MFIs, and the impossibility of managing as many clients as staff were expected to serve (based on unrealistic targets that were the basis for awarding generous bonuses) using the traditional approach. It is not clear that MFI leaders were aware that this was going on, or whether they just turned a blind eye.

I was aware that most of the smaller AP MFIs who do not have operations outside the state have effectively gone bankrupt. What I learned from sitting down with four leaders of these now defunct institutions – who predictably though plausibly claim to have been largely innocent of the abuses committed by the larger MFIs based in the state – is that two AP MFI promoters (i.e., founders) who were distraught by their life’s work being ruined have recently committed suicide, and more are feared.

Another thing I learned while speaking to the smaller MFIs is that they are now being sued by Ananya, a non-bank finance company set up by the respected wholesale lender Friends of Women’s World Banking. (The CEOs came from across the state to meet with me on the day when they were consulting with their legal advisors.) They claimed that they needed to dig into their dwindling personal assets to hire lawyers. I was told by others that Ananya is being required to file these suits as part of its own difficult negotiations with its lenders.

At least one large AP MFI is optimistic about the future, feeling that it can recover 50-70% of its portfolio once the AP Ordinance is repealed (which would likely happen as a consequence of federal legislation being enacted later this year, though perhaps only after India’s Supreme Court gets involved) and it can issue fresh loans to those who pay off arrears. Based on a two-hour session with about 20 clients (pictured below) handpicked by this MFI for me to talk to, it is difficult to dismiss this claim despite conventional wisdom that holds that AP portfolios are unrecoverable. (One client, Devamma, was particularly articulate in praising her MFI and blaming the local political leaders, bureaucrats and moneylenders who conspired to shut it down.)

AP Microfinance Clients Posing for a Picture After Talking with Me

Many have noted that MFIs should have been more actively engaged in building bridges with local politicians and bureaucrats. What I heard for the first time was that MFIs also have learned how important it is to pay attention to members of the media. Among the many criticisms of SKS and its public offering – which most agree was a catalytic event that transformed animosity into confrontation – is that it failed to spend much if any of its pre-IPO advertising budget in its home state (preferring instead to spend it where it believed the investors were, namely in Mumbai and in the state of Gujarat).

Many have noted that the perception and/or reality of good ‘ole greed on the part of MFI investors and management played a role in precipitating the crisis. What I heard for the first time is that greed on the part of clients themselves may have played a role (though some dispute this). The argument is that many borrowers – unfortunately and tellingly, none were savers – knew they were getting into too much debt but reasoned that since everyone else was, the loans were ultimately going to be forgiven somehow (as has often happened in India, especially in the case of government loan programs). So, they took as much as they could and pressured people who wanted to repay not to do so.

Many have also noted that MFI clients did not rally and protest against the anti-MFI Ordinance. The reasons typically cited are that borrowers did not feel a strong bond to their MFI(s) and perhaps resented their poor service. Based on my point immediately above, one could also argue that they simply liked the idea of not having to repay their loans. However, there is a much easier explanation: that they saw a fight brewing between the private MFIs and the state government, were effectively forced to pick sides, and picked the stronger party (the government) since it was likely to prevail. They reasonably concluded that being aligned with the losing side might carry risks of reprisal well into the future.

Devamma, an outspoken advocate of her AP-based MFI — one that has been much maligned in the media

There is another reason I am trying to get to the bottom of this crisis. I have been asked to address the closing session of the Indian microfinance association Sa-Dhan’s annual conference in August, which is a major honor especially for a foreigner. (Increasingly self-confident Indians are more likely than ever to resist solutions, ideas and models implanted from outside the country.) The topic for the closing session is the future of microfinance in India, and I welcome input from loyal blog readers for my remarks.

What does all this mean for Fonkoze? With one possible exception that is years old and was brief, Fonkoze never got caught up in growth for growth’s sake, especially growth that led to cutting corners on staff training, outsourcing key functions to local “agents,” and stripping down product offerings. In terms of building bridges with local media, government officials and politicians, Fonkoze has recently stepped up its outreach. But will it be enough to prevent some future backlash along the lines of what we have seen in Bangladesh and India (and other mature markets such as Bolivia)? Only time will tell.